We have observed a pronounced
and increasingly broad-based slowdown of consumption growth in recent months,
including that of staples consumption. Such a phenomenon implies that employment
and household income growth may be under pressure. Discretionary consumption
growth took a big step down in 2H 2018. The most noteworthy drag to
discretionary consumption was auto – both the price and volume of passenger car
sales declined YoY in China for the first time ever in 2018; meanwhile, China’s
smartphone market has been shrinking since around mid-2017, echoing Apple’s
downward revision of revenue guidance earlier this month. More alarmingly,
however, staples consumption growth also started to stall, particularly those
consumer staples which cater to “consumption upgrading”, e.g., bottled water,
meat products and fruit drinks. To the extent that discretionary consumption
growth is more closely related to corporate profitability growth, the pressure
on staples consumption growth clearly indicates changes in the employment
situation and household income growth.

In our view, the recent
deceleration of consumption growth results from the combined impact of multiple
factors, some of which may gradually dissipate. However, the pressure of
employment and household income growth may rise. Looking forward, changes in
employment and household income growth may become the driving force of
consumption, for discretionary and staples products alike. Granted, consumption
deceleration in recent months was driven by a number of overlapping factors,
including (i) a deteriorating labor market (i.e., heightened pressure on real
unemployment rates and household income growth), (ii) the tightening of
non-mortgage consumer loans, and (iii) the negative wealth effect from the
sizeable correction of financial market valuation. Looking forward, some of
these factors (e.g., consumer loan tightening) may dissipate. However, as we
have analyzed in a recent note, we believe that the pressure of employment and
household income will likely continue to unfold on many fronts this year,
considering that corporate profitability is weakening, the property cycle is
softening, external demand remains uncertain, and “modern” services industries
are switching to slower growth. In light of a deteriorating labor market,
further downside risk looms for consumption growth, including staples geared
towards “consumption upgrading”, big-ticket items, services, and housing-related
consumption. Even worse, rising deflationary expectations will further deter
consumption growth, as deflationary impulse reduces the “opportunity cost” of
delaying consumption, especially for items with more volatile and cyclical price
movements.

Looking forward, investors and
policy makers should closely monitor changes in corporate profitability growth,
as well as the number of loss-making firms and the loss amount. These indicators
may reflect labor market trends and changes in household income growth, and thus
may be a useful gauge for consumption “turning point” this year. As we’ve
analyzed, while there is no good-quality, high-frequency data that can be used
to effectively evaluate short-term labor market conditions, changes in household
income growth are closely tied to economic cycles through its impact on
consumption and aggregate demand. Corporate profitability (and on the flip side,
the number of loss-making firms and the loss amount) sheds light on the pace of
household income growth, and therefore could be a useful gauge for consumption
“turning point” this year. Importantly, industrial enterprise profit growth
already turned negative in November 2018 for the first time since December 2015,
indicating that the “negative feedback loop” between slowing consumption,
deteriorating corporate profitability, and decelerating household income growth
is potentially forming. Looking forward, it is not inconceivable that corporate
profit growth may record a YoY contraction rate in the mid-teens this year.
While the recent plan by the NDRC to stimulate consumption demand is a welcome
move, the room for boosting consumption through fiscal expenditure growth may be
limited – our analysis already showed that fiscal (deficit) expansion this year
will largely be driven by the “automatic stabilizer” effect from the naturally
slower government income growth, and that the broad-based fiscal “funding gap”
would amount to more than Rmb2.5 trillion in order to just maintain the current
pace of fiscal expenditure growth.